“Don’t buy a Fiat 500e electric car” says the company’s chief executive, Sergio Marchionne. According to Mr. Marchionne, it has nothing to do with the quality and price of the car, but rather the cost associated with producing the car – specifically the battery – and its impact on the product’s profit margin. The chief executive admitted at a recent appearance, “I hope you don’t buy it because every time I sell one it costs me $14,000.”
As a business owner, it is easy to see if you are profitable, just take a look at your company’s net income; however, that number alone does not provide a complete picture. Fiat is a perfect example. Overall, the company is profitable; however, when you look at the profit margins for their individual products, they are actually losing money on one of their product offerings.
For a more accurate measure of how your company is doing, it is imperative to calculate your profit margins by product line.
Calculating Profit Margins
Profit margin is an accounting measure designed to calculate your profit as a percentage of sales. It can be used to evaluate your business as a whole or for each individual product line.
Why is this useful? The two main reasons are 1) to compare your profit margins on a monthly and/or yearly basis and 2) to establish your position against other companies in your industry.
To calculate gross profit margin, divide your gross profit, which is sales minus cost of goods sold, by sales.
Analyzing Profit Margins by Product Line to Increase Profitability
Let’s assume your company has $10,000 in sales for the month and your gross profit for that same month is $5,000. That would mean your company’s gross profit margin is 50%.
Some business owners may see these numbers and think “we’re doing great” and they might be; however, by taking a closer look at the company’s profit margins by individual product line, they may be able to identify opportunities to increase profitability even more.
Using the same example above, let’s assume that Product A generated $7,000 in sales for the month and had a gross profit of $3,000. Product B generated $3,000 in sales and had a gross profit of $2,000. In this example, the gross profit margin for Product A would be 42.9% and for Product B would be 66.7%.
$3,000 Gross Profit / $7,000 Sales = 42.9% Gross Profit Margin
$2,000 Gross Profit / $3,000 Sales = 66.7% Gross Profit Margin
Using this information, a company could consider adjusting their pricing and distribution strategies to increase their overall profits. One way to achieve this would be to increase the price or reduce the cost of goods sold for Product A to improve the gross profit margins for that product line. Alternatively, the company could adjust their promotional efforts to focus more on selling Product B since the margins are greater.
Referring back to the Fiat example, the company is unable to increase the price for their electric vehicle because the market will not bear it. They should eventually be able to reduce the manufacturing costs of the car battery, but that will take time. So for now, it seems that Fiat is taking the alternate approach and focusing their promotional efforts on their other product lines.
Improve Your Company’s Profitability
At Signature Analytics, we work with our clients’ management teams to properly identify and understand the profit margins of their business. This is accomplished by producing a detailed understanding of the cost structure and related sales price associated with each product line and revenue stream of the company. This profit analysis can also be shared with company investors and banking relationships to enhance investor relations and participation.
In addition to profit margin analysis, we can provide accurate forecasts and budgets that enable our clients to properly project EBITDA growth and allow for better cash management strategies. All of these accounting and financial reports – profit margin analysis, forecasts, and budgets – empower our clients with the financial information they need to make informed business decisions that help to increase overall margins and improve profitability.
Want to learn more about all the ways Signature Analytics can help improve your company’s profitability? Contact us for a free consultation.
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